Rare diseases have supported a very strong run in BioMarin's stock.

It's not easy to develop treatments for rare diseases, but it is hard to argue with the rewards. Prior to its acquisition by Sanofi(NYSE:SNY), Genzyme had already established itself as an important player in enzyme replacement therapies, and Shire(NASDAQ:SHPG) and Alexion(NASDAQ:ALXN) have both gone on to find meaningful success with treatments that serve tiny patient populations, but carry huge price tags.

BioMarin(NASDAQ:BMRN) very much deserves to be in this conversation, as the company has one of the broadest portfolios and pipelines for rare diseases. BioMarin's pipeline definitely has clinical risk and I don't think investors should just assume that payers will always go along with the pricing these companies want. The biggest issue may be overall expectations, though, as BioMarin is going to have to become extremely profitable and deliver exceptional revenue growth just to meet current expectations.

Three solid contributors, and a new one comingBioMarin got its start like many biotechs do; its oldest drug, Aldurazyme, was developed by BioMarin and approved by the FDA in 2003, but is marketed by Sanofi/Genzyme. This enzyme replacement therapy for mucopolysaccharidosis I (MPS I) still contributes about 15% of the company's revenue.

Since then, BioMarin has added Naglazyme, an enzyme replacement for MPS VI that contributes almost half of the company's revenue, Kuvan (for mild-to-moderate PKU), and Firdapase for LEMS. Firdapase is a small part of BioMarin's business (less than 5% of revenue) and the company out-licensed U.S. rights, while Kuvan is close to one-third of the company's revenue.

Most recently, BioMarin received FDA approval to market Vimizim. Vimizim is an enzyme replacement therapy for the treatment of MPS IV-A (also called Morquio syndrome), a rare disease that causes a wide range of developmental problems. As is the case for most of the diseases that BioMarin, Alexion, Genzyme, and Shire target, the treatable population is small (likely no more than 4,000 or 5,000), but BioMarin has priced the treatment at $380,000 per year in the U.S.

Due to the small patient population with this condition, there are only a relatively small number of physicians and medical centers that treat it. That makes it significantly easier for BioMarin to market this treatment, and rare disease treatments tend to reach peak sales faster than for other therapeutic areas.

A deep pipelineBioMarin has done well by developing and marketing treatments where no alternatives exist. While the company's current pipeline does include treatments that would be the first and only available treatments for their targeted markets, BioMarin is increasingly looking at markets where there will be competition.

PEG-PAL is in late-stage studies for PKU and while it does offer benefits (and addressable patient populations) above and beyond Kuvan, there could still be about 20% to 25% cannibalization of Kuvan. Efficacy and side effects still need to be sorted out; earlier studies have established impressive potency (and may allow PKU patients to eat more or less normal diets), but adverse events are still a possible issue.

BMN-701 is BioMarin's entry into Pompe syndrome, a market currently dominated by Sanofi/Genzyme's Myozyme/Lumizyme. There have been some signs that BMN-701 is more effective than Lumizyme, but head-to-head studies may be required to drive significant market share shifts.

The biggest potential head-to-head contender in BioMarin's pipeline is its BMN-673 PARP inhibitor for cancer. PARP inhibition is a somewhat popular target, with Clovis, AstraZeneca, and AbbVie all developing PARP inhibitors, and there are multiple alternatives for markets like breast cancer and ovarian cancer. Given the larger number of competitive compounds and treatment centers, marketing BMN-673 (should the data support approval) will be a new challenge for BioMarin.

Significant growth a must-haveIf BioMarin is to work as a stock from here, the company must deliver some torrid revenue and profit growth. Although historically not a free cash flow generator, I believe that BioMarin will likely start producing positive free cash flow in 2016 or 2017. From that point, I expect significant cost leverage and I believe that BioMarin can join Alexion and Shire in the 25%-plus FCF margin club. In fact, I am willing to model 35% free cash flow margins for BioMarin.

The problem is that BioMarin still needs exceptional revenue growth to generate enough free cash flow to justify today's price. By my estimates (and using a range of discount rates), BioMarin needs somewhere between $4.5 billion and $5.5 billion in 2023 revenue just to validate today's price, and that's a steep hurdle next to trailing revenue of about $550 million.

Vimizim could be a billion-dollar drug, and PEG-PAL and BMN-701 combined could be worth more than $1 billion in revenue. BMN-111 for achondroplasia could be a $2 billion-plus drug and other, more distant, compounds like BMN-190 and BMN-250 could prove significant as well. If the PARP inhibitor BMN-673 becomes a blockbuster (not a ridiculous thought given early stage data), BioMarin could get that $5 billion in incremental revenue it needs. Clearly that doesn't leave much room for clinical setbacks/failures, nor significant pricing pushbacks from payers.

The bottom lineEuropean regulators have been getting tougher about drug pricing, and that does concern me some when it comes to BioMarin, particularly if U.S. payers get into the act as well. I'm also somewhat concerned about the prospects for gene therapies offering competitive challenges to BioMarin's approved and experimental products (though these therapies are likely more than five years away from commercialization, at best).

What I'm more concerned about is the take-no-prisoners valuation. BioMarin is hardly the only expensive-looking stock in the biotech space and the company deserves a premium for its R&D/pipeline success and focus. Perhaps the stock isn't mispriced on a relative basis, but the high level of success the company needs just to validate today's price would make me a little wary about buying in today.